Thank you for standing by. This is the conference operator. Welcome to the lululemon athletica Inc. Second Quarter 2023 Conference Call. [Operator Instructions] And the conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Howard Tubin, Vice President, Investor Relations for lululemon athletica. Please go ahead.

Thank you, and good afternoon. Welcome to lululemon's second quarter earnings conference call. Joining me today to talk about our results are Calvin McDonald, CEO; and Meghan Frank, CFO. Before we get started, I'd like to take this opportunity to remind you that our remarks today will include forward-looking statements reflecting management's current forecast of certain aspects of lululemon's future. These statements are based on current information, which we have assessed, but by which its nature is dynamic and subject to rapid and even abrupt changes. Actual results may differ materially from those contained in or implied by these forward-looking statements due to risks and uncertainties associated with our business, including those we have disclosed in our most recent filings with the SEC, including our annual report on Form 10-K, and our quarterly reports on Form 10-Q. Any forward-looking statements that we make on this call are based on assumptions as of today, and we expressly disclaim any obligation or undertaking to update or revise any of these statements as a result of new information or future events. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our quarterly report on Form 10-Q and in today's earnings press release. In addition, the comparable sales metrics given on today's call are on a constant dollar basis. The press release and accompanying quarterly report on Form 10-Q are available under the Investors section of our website at www.lululemon.com. Before we begin the call, I'd like to remind our investors to visit our investor site where you'll find a summary of our key financial and operating statistics for the second quarter as well as our quarterly infographic. Today's call is scheduled for 1 hour so please limit yourself to 1 question at a time to give others the opportunity to have their questions addressed. And now I would like to turn the call over to Calvin.

Thank you, Howard. I'm pleased to be here with everyone to discuss our quarter 2 results. Today, I'll share the highlights of our recent performance and speak to some of the exciting product launches and activations we have planned for the second half of the year. As you've read in our press release, our second quarter results exceeded our expectations as our core product and new launches continue to resonate strongly with guests in markets around the world. On today's call, I will provide details on our quarter 2 performance, I'll then speak to our outlook and the many opportunities we have across the business. Next, I'll turn it over to Meghan for a review of the financials and the guidance update, and then we'll take your questions. So let's get started. Our business remained strong in quarter 2 with both revenue and EPS exceeding our expectations. Revenue increased 18% versus last year with strength across our portfolio. Comparable sales grew 9% in stores and 17% in our e-commerce business and adjusted EPS increased 22% versus the same period last year. These results demonstrate the strength of the business and how we are well positioned for the second half of 2023. In fact, we are seeing our strong momentum continue into quarter 3 and expect revenue growth in the 17% to 18% range for the quarter. Meghan will share our detailed guidance with you later in the call. Let's now look at quarter 2 in more detail as I share some highlights on product innovation, brand building strategies and regional performance. When looking at product, we posted strong double-digit growth across women's, men's and accessories as we bring newness and innovation into our assortment. Specifically in quarter 2, women's increased 16%, men's was up 15% and accessories increased 44%. In…

Thanks, Calvin. Our momentum remains strong in Q2, enabling us to exceed both our top and bottom line guidance. In addition, our inventory growth continued to moderate about 14% versus our guidance of approximately 20%, and it remains well positioned from both a level and composition standpoint. I'm also excited to see our sales strength continuing into Q3 as guests are responding well to our back-to-school and early fall product innovations. Now let's dive into our Q2 financials. For Q2, total net revenue rose 18% to $2.2 billion, driven by broad-based strength across the business. Comparable sales increased 13% with a 9% increase in stores and a 17% increase in e-commerce. In our store channel, total sales increased 21% versus last year. We ended the quarter with a total of 672 stores across the globe. Square footage increased 19% versus last year, driven by the addition of 72 net new lululemon stores since Q2 of 2022. During the quarter, we opened 10 net new stores and completed 4 optimizations. In our digital channel, revenues totaled $894 million or 40% of total revenue. Within North America, revenue increased 11% versus last year. Within international, we saw a 52% increase versus last year with Greater China increasing 61%. And by category, women's revenue increased 16% versus last year, men's increased 15% and accessories grew 44%. It's also great to see ongoing strength in traffic across both channels. In both stores and digital channels, traffic increased over 20%. This speaks to the strength of our omni operating model as we engage with our guests in ways most convenient to them. Gross profit for the second quarter was $1.3 billion or 58.8% of net revenue compared to 56.5% of net revenue in Q2 2022. The gross profit rate in Q2 increased 230 basis points…

Thank you, Meghan. As these results demonstrate, we arrive at the midpoint of 2023 in a very strong position for what's ahead. We continue to deliver sustained growth in the business through a steady drumbeat of product category and market expansions that connects us with our guests on a regular basis. We recognize the significant opportunity in front of us and we remain focused on both delivering a successful 2023 and achieving our goals contained within the Power of Three x2 growth plan. My confidence in our leadership and our people remains extremely high as we consistently demonstrate our ability to deliver for our guests and our shareholders. I'm grateful to the many teams across lululemon who champion our brand every day and make these results possible. And now we look forward to taking your questions. Operator?

[Operator Instructions] The first question comes from Matthew Boss with JPMorgan.

And congrats on another nice quarter. So Calvin, could you elaborate on the broad-based global strength, notably customer demand that you saw in North America and China as the second quarter progressed. And then on more recent trends, could you just speak to drivers of the strong August momentum and the acceleration that you cited in North America?

Great. Thanks, Matt. Similar to the success through the first half of this year, which is really driven from our core product as well as our new innovation across both performance and OTM categories across both women's and men's -- so it continues to be that balanced growth across categories, channels, both stores, e-comm and all markets that's fueling the business. And heading into Q3, there's really no change to that formula, and the team is doing a wonderful job and guests are responding to the new innovation that we are launching. I referenced a few on the call, the soft jersey, steady state for him. We have some exciting innovation still to come. So I think it's just a continuation of low unaided brand awareness, and we are launching initiatives to get at that opportunity, incredible product opportunity and the teams delivering on that on unmet needs and our international business, which, in addition to North America is still performing very strongly, double-digit in line with our Power of Three x2 growth targets, seeing acceleration across every market in the globe we're in. So -- it really is a reflection of my consistent message of us being early innings and balanced growth across all opportunity we have and a team that's delivering on that potential.

That's great. And then, Meghan, could you just speak to the overall health and composition of your current inventory position as we head into the back half. And just how best to think about markdowns in the third quarter? Or are there any constraints to recapturing the markdown headwinds that you incurred in the fourth quarter a year ago?

Yes, absolutely, Matt. So in terms of inventory, so we came in up 14% at the end of the quarter, our expectation was approximately 20%. Relative to our expectation, there were a few items that drove that balance lower. So the first would be revenue upside above our expectations. Second being lower air freight costs and then the third being some timing implications. And in terms of how we're looking at inventory for the balance of the year, at the end of Q3, we're expecting high single to low double digits. And then in Q4, end of Q4, relatively in line with sales as we move into 2024. So I would say overall, we're really pleased with the currency and also the level of our inventory. In terms of markdowns, nothing really to note on the quarters. We're still expecting markdowns to be relatively flat on an annual basis for '23 over '22, and that's consistent also with our 2019 levels, which is a normalized healthy level for us. We run a low markdown penetration, high full price penetration business. We were flat in Q2, markdowns year-over-year, and I wouldn't expect any anomalies in Q3 and Q4.

The next question comes from Adrienne Yih with Barclays.

Great. Congratulations. The results are really -- they really stand-alone. Calvin, so the business is being driven by innovation, product launches and newness, whereas sort of the competitive backdrop is a little bit more safe. And I'm just wondering how -- have you been able to sort of inspire that? It feels like you're innovating faster. Every time you get on a call, there's like another list of 5 new things that we didn't know about. So I'm just wondering, have you accelerated the innovation turnover time, the pipeline or the investment? And then Meghan, if you can just talk to us about kind of the China, the opportunity there, the sales are almost double sort of what you have in Canada and the year-to-date sales are roughly similar at $0.5 billion. So just kind of talking about the improvement there and what you think about the opportunities there?

All right. Thanks, Adrienne. In terms of our speed of innovation, I would agree that the pipeline and the launches within each quarter continue to get very strong and excited about the balance across our accessories business, our women's business, our men's business. I think it is an execution of a very deliberate innovation strategy that we've been working through the Power of Three and into the Power of Three x2 strategy. You've heard me reference our play categories and being very deliberate in terms of what we design into and then leveraging our core, how we leverage versatility, but continue to innovate against some of those core hero franchises that he and she loves so that we don't simply launch and then just allow it to run without enhancements, improvements and adding to. Sharing across gender. For instance, in this quarter, we took our famous scuba fabric and brought that into a steady state for him, which was an opportunity we saw in our assortment that we were missing. So I think what you continue to see is just the team executing on the strategy. We have a horizon of innovation across horizons 1, 2, 3, which can be anywhere from 1 to 3, 4 years as we keep looking to solve the unmet needs of our guests and where and how, but we have a lot that we're able to bring forward and commercialize as well as having a lot that the team continues to work on for future quarters and future years. And feel very excited about our ability to sell through core, innovate core and then bring true innovation to the guest through that notion of unmet needs versus unmet wants. And I think that's driving our business that we're truly solving, which is a unique standout in this marketplace.

And then, Adrienne, in terms of China, we are really pleased with the performance there in the quarter, up 61% in Greater China. We have 100 stores today in China. We're opening 35 stores in an international region this year, the majority of those in the China market. As Calvin mentioned, we've had some exciting community activations still looking to build brand awareness and drive into that opportunity there. And then over the longer term, we've set approximately 200 stores at the end of our 5-year plan, and I think -- there's also a beyond there as well in terms of still very early innings on our China growth.

Fantastic results. Best of luck.

Thank you.

The next question comes from Lorraine Hutchinson with Bank of America.

Meghan, you've pulled a lot of investments forward into 2023 as gross margins continue to be. Can you give us some examples of the most successful investments? And then also talk to your ability to generate leverage on this line item as we move into 2024?

Absolutely, Lorraine. So we've been really excited with the revenue momentum we've had and then also the progress that we've made on recouping air freight expense. So our guidance now on revenue is 17% to 18% growth ahead of our original target and then margin, guiding to 190 to 210 basis points with airfreight really being the driver there. So what it's done is it's given us the ability to invest behind our Power of Three x2 road map. So that would include market expansion, notably international, specifically China as a key focus there, improving guest experience and omni capabilities and then a foundational investments to drive the business forward. And I think coupled with that, what we're really excited with is you heard us talk on Analyst Day about the tremendous opportunity we have in brand awareness. And this upside has given us an opportunity, particularly in the second half of this year to invest in marketing activations to drive that brand awareness, really capitalizing on some of the key innovation moments we have coming up in the second half of the year. So that, we believe, will drive into our long-term opportunity and sustain our momentum. So we're a little bit ahead of where we were. We were expecting to be from a Power of Three x2 initiative road map, and then that's coupled with driving into some upside opportunity on brand awareness. In terms of leverage, we're really focused on operating margin and feel good about maintaining our commitment to modest operating margin expansion over the longer term. I think as we get closer to '24, we'll put a finer point on where we see the components of the P&L shaping up next year.

The next question comes from Paul Lejuez with Citi.

Just want to talk about the China business. Would love to hear about what sort of volatility you saw in China over the quarter. And if you could talk about how stores performed versus e-comm? And where are store productivity levels running in China currently versus North America?

Paul, I would say in terms of China volatility, we really didn't experience any over the course of the quarter. I would say, really strong healthy growth across each of the 3 months of the quarter. And then I'll let Calvin comment on store and e-comm performance.

In terms of both channels, they're performing incredibly well in the market. We now have 107 stores in Mainland China, predominantly Tier 1, Tier 2 cities, but still see opportunity to grow as well as look to opportunities into Tier 3. Every store we've opened has exceeded plan, our optimization of some stores as we did with our Kerry Center location, which is really our first bigger, more experiential store in country is performing incredibly well. And as you know, online business in China is different than that of other markets where our .cn is a lower percentage of our overall business, and we do work through partners such as Tmall, JD to grow our business. But on the back of those platforms and leveraging some of the B2B and working direct and selling direct to our guests through their clienteling platform. The team is doing some incredible initiatives and learnings for us globally and driving the overall e-commerce business. So very strong in both -- great guest acquisition in both -- it's helping us determine new markets, new opportunities and locations that we can continue to open and build into. And our stores are really driving the brand the way in which we traditionally do in all markets, which is grassroots community and through the educators. And from a productivity standpoint, they're behind North America, but performing very well, just slightly behind. They're smaller in size, but we see a significant opportunity, obviously, in the success of that -- of our store footprint, both productivity driving the brand, coupled with e-comm. So very exciting and good and balanced growth across all of those levers.

So what's the profitability in that China market currently versus where you think it can go longer term?

Yes. I'd say we haven't broken out the profitability specifically. It's very healthy. Closest to our North America region. I think in the near term, what we're really focused on is capitalizing on the opportunity we have in that market, not necessarily maximizing that operating margin, but that would present an opportunity also over the long term as we scale that market.

The next question comes from John Kernan with TD Cowen.

Excellent. Calvin, when you talk to international up 52%, I think it's 23% of revenue now. I guess this dovetails into Paul's question, the margin structure of this business is seemingly very high. I think this is your highest quarterly gross margin in history in the second quarter. So maybe just talk to internationally broadly about how that's contributing to the margin expansion you're seeing this year?

I'll tee up relative to the market, the success you mentioning at 23% of our sales and where we see the potential across the market. I'll let Meghan speak to the margin. I think we indicated on the last quarter that in every market, every region we're in, we're profitable and early innings of growth didn't seem that long ago when international was 14% of our total sales, 15% of our total sales. So to be crossing the 20% consistently to have it contributing to the growth of the overall business is incredibly exciting to see every market we're in, the business growing double digit and consistently and having some of the lowest unaided brand awareness we have in the company. It's single digit in every market, except for Australia and the U.K. where we've been in the longest, but even there, it's in the teens. So we have a significant runway of growth in international business. And at 23%, I think we really are just getting started. I've shared before that the potential of this brand is, I think, 50-50 beyond our current Power of Three x2. But I don't see anything that would hold us back from being a global brand to that scale, diversified and balanced in multiple markets. and all markets today being profitable with significant growth through product unaided brand awareness. And Meghan, if you want to touch on the margin mix?

Yes, absolutely. So for the full year, we guided a 40 to 60 basis points of expansion in operating margin year-over-year. That's about 20 to 40 basis points above 2019 levels. So we're really pleased with that performance. Within that international is still below North America profitability. As I mentioned, China being the closest really looking to maximize that market. And then APAC and EMEA, still some opportunity in terms of operating margin expansion in the near term as we continue to scale those markets. So I would say, over the longer term, focused on driving into the brand awareness and revenue opportunity, store expansion we have in the international market, scaling and leveraging over time.

Excellent. My 1 follow-up is just on other categories. It's obviously been a bigger driver of revenue. It should be well north of $1 billion annually this year. You talk to the growth of that category line item and how we should think about that going forward?

Yes. So within our other categories that are franchise businesses as well as seasonal pop-ups, those would be the largest components. We also have outlets in lululemon Studio. I would say the growth being driven by new franchise markets as well as relatively consistent, I would say, performance in terms of seasonals and pop-ups. And so I would say we'll continue to scale markets within that bucket and capitalize on the opportunity we have there with our franchise model with another going forward.

The next question comes from Brian Nagel with Oppenheimer.

Congrats on another nice quarter. Two questions, I'll shove together. I mean first, I apologize if this is repetitive, but you talked about the further strengthening of your business here into fiscal Q3, specifically August. So -- can you help us understand better, I mean, where -- what's driving that? Are there particular product categories, particularly geographies you're seeing that happen? Then I have a follow-up.

Thanks, Brian. I think it's a combination of some of the new innovation that came out at the tail end of Q2 that is set up in position for sort of back half needs in men's. We've seen incredible response to the soft jersey and steady state. We're geared up for the ABC campaign of Get Into It, which I'm really excited about, having men's play along with women's being featured in that. We've activated accessories across our bags. We've done some digital campaigning in certain regions relative to back to campus, which has resonated well and driven some of our core products in terms of the bottoms in both women's and men's. So -- it's been a variety of activations, a combination of getting at unaided awareness through campaigning, leveraging our core as well as some newness and innovation that is resonating in both he and she are responding very well to and that's consistent across all markets, and we've seen a nice response in North America. So it's a similar formula, a similar approach to that, really driven, I think, from a North American business has responded well, I think, as we head into the fall and back to campus.

That's very helpful, Calvin. I appreciate that. And then my follow-up question with regard to inventory. So just look at the numbers and given your comments, I mean, you've done a phenomenal job of really rationalizing if you will, inventories. So my question, I mean, given the level of concern that was in the marketplace, say, just a few quarters ago about inventory, both on lulu and in the channel. As you look at your inventories now, are we -- recognize you always have to manage inventories, but are we really now past that critical point? Is there some type of all clear with regard to your inventory and the cleanliness of that inventory?

Yes. I mean I would say we've made some significant progress. We still have some degree of elevated airfreight in our inventory balance on a cost basis. And so I would say not completely optimized and turns are a little bit slower than history, and our goal over the longer term would to get those inventory turns back to normalized historical rates. So still some opportunity, but I think the team has done a nice job in navigating what was a really dynamic supply chain and positioning inventory so that we were able to capitalize on the demand upside that we saw and experienced.

The next question comes from Dana Telsey with Telsey Group.

Congratulations on your terrific performance. It's great to see the progress. As you think about the traffic, which was so impactful, both for stores and for e-commerce. Any discussion regarding the loyalty programs? Is that a driver of this? And where do you stand on the loyalty programs with that enhancement? And then Calvin, as you're mentioning new product, I know outerwear is a big thing for last year. How do you see the AUR developing? And are we moving into a higher AUR zone going forward with some of the newness?

Thanks, Dana. As you mentioned, the traffic was very strong and pretty much completely in line across both stores and e-comm. So continuing to drive that omni strategy and have the guests connect with us wherever is convenient for them, has been a strategy of ours and continues to resonate and drive our business. And we're cycling over the success of some categories and items last year that really drove traffic. So very healthy, strong numbers on top of strong numbers, which is very encouraging as we look at just how the guests both new and existing are engaging with us. I think membership is a part of that. We've had it before membership, but with the membership program obviously is allowing us is more deliberate ways to engage with that guest. And I mentioned that it's not going to be a number we consistently share. But I will indicate that the program continues to far exceed our expectations. We launched this less than a year ago. And we now have 12 million of our guests signed up in North America to the Essentials membership program, which is a significant unlock for us, our teams, it allows us to play into our strength of community, relationship, allows us to leverage benefits that are unique to that guest to that member. And allows us to interact with data and communicate with them that is very effective for our digital marketing teams as well as our store teams and look at the history and assist the guests in the way in which we do. So it is an exciting new program for us that we have a lot of ideas and initiatives planned, how we will continue to leverage. I think it's a part of it. I wouldn't point all to it. I think ultimately, it's the success of the brand, success of our product and product innovation, why the guests comes to lululemon. And we see that continuing through for the Power of Three x2 period and beyond.

The next question comes from Ike Boruchow with Wells Fargo.

Just 2 clarification questions for me. Just on the quarter-to-date North America acceleration, is that full revenue comp or both? And then on China, 60% growth was great. Just kind of curious in terms of the revenue guidance for the remainder of the year, what kind of growth are you guys baking in for China for the back half?

Thanks, Ike. So in terms of the acceleration in North America specifically, it would be total and comp. In terms of China, we haven't broken out the second half of the year by region. But we are coming off a very strong performance, 61% growth in Q1 -- sorry, Q2 in Greater China. And feeling well positioned as we move into the second half of the year, as I mentioned, 107 stores in China today, 35 stores international. And the majority of those being China openings. And I would say we're pleased with our performance in China as we move into this.

The next question comes from Brooke Roach with Goldman Sachs.

Calvin, I was hoping you could elaborate on the composition of North America growth between new and existing customers. How are those customer cohorts performing as they enter the brand? And are you seeing any difference in customer behavior by age or income demographic?

Thanks, Brooke. In terms of the overall composition, I'll speak directly to sort of how we view the cohorts. And I think I've mentioned before, that the new guest cohorts are performing and behaving very similar to how that cohort has behaved in past quarters, past years. That's very encouraging for us because we did see through the success last year of the Everywhere Belt Bag that it did pull in a younger guest to see them in the cohort and that cohort behaving similar nature of how they engage the frequency of engagement and the migration of their spend is encouraging. And we still see our business driven by new guests coming in as well as our team's ability to retain existing guests and increase share of wallet and spend with them. So nothing that would signal they're behaving differently in very healthy and contributing factor to the overall business, both with new existing very low retained, very high guest loyalty, longevity and engagement in the brand and responding to the newness and the innovation continues to sort of be that guest formula.

Operator, we'll take 1 more question.

The next question comes from Alex Straton with Morgan Stanley.

Congrats on another good quarter. One for me. Just on the stores, it looks like they could be at over $6 million a pop in revenue or so on average this year. It's definitely a high number per box. So I'm just wondering, maybe Meghan, how do you think about the trajectory from here? What drives that number higher? And on a related note, how do you think about the store growth opportunity from here in North America specifically?

Thanks, Alex. So in terms of sales per store and sales per square foot, it's definitely a key part of our strategy to expand our box size in locations where we have high sales per square foot, high traffic to capitalize on that traffic. So we are opening approximately 25 what we call co-located stores, which are really expansion. It allows us to have a more holistic assortment across men's, women's accessories, footwear and as I mentioned, capitalize on that traffic trend. So it's a key strategy for us and one that we monitor closely. We're definitely further along in that strategy in North America than we are in our international markets, we're still very early days on that. But still runway, I would say, across both our North America and international region in terms of store expansion and a very measured and deliberate strategy. And then I would say -- sorry, can you remind me the second half of your question?

On the store growth opportunity in North America, specifically?

We haven't broken out the specifics, but I would say we're not dissimilar from this year and square footage growth in the low double digits range. Globally, high single digits in North America.

That's all the time we have for questions today. Thank you for joining the call, and have a nice day.